Many leases provide for a tenant improvement allowance to be paid to the tenant by its landlord toward the construction of the tenant’s initial buildout of its space. Tenants must be sure that their leases include clear procedures and remedies to ensure that the landlord meets its obligations to timely pay such allowance.
In today’s issue, we provide eight suggestions to cover when negotiating a construction allowance under your lease.
Mintz & Gold LLP
Survival of the Fattest (Tenant Improvement Allowance)
Yes, I too have cabin fever.
Too much COVID. Too much social distancing. Too many Zooms.
Not to mention election wackiness.
And a long winter ahead of us.
As those of us able to work from home sit in our sweatpants and reward ourselves with another snickers bar for actually working for fifteen straight minutes, we all face the dreaded COVID 19.
No, not the virus. I mean the extra 19 pounds of banana muffins, chocolate chip cookies and M&Ms we have devoured.
Hey, c’mon, don’t disturb us – we’re binge stress chowing over here!
But bear with me, since for some ballooning up is a healthy part of winter hibernation.
That’s right, Fat Bear Week’s slogan is “survival of the fattest” as each year Katmai National Park in southern Alaska hosts a fattest bear contest to crown the King or Queen Tubby that best gets ready for a long winter ahead.
The regulars chomp down a year’s worth of food between June and October before taking a winter long nap (some of us have also achieved that goal – you know who you are!).
No shaming here – a fat bear is a healthy bear since the bears do not eat or drink during hibernation and need to live off their hard munching work during the rest of the year.
And these butterbears have to do their fridge devouring without the stress of reading another lease – true pros!
The park actually creates a March Madness (March Fatness?) style bracket described as “a single-elimination, no-holds-barred, completely subjective tournament.”
And for true aficionados there is even a literal livestream where fans can watch the contestants best able to add four to five pounds a day down by the river with their salmon catching skills.
Before and after pictures of the finalists, aptly named “747” and “Chunk 32”, are set forth below, and Leasing Illustrated offers its artery hardening congratulations to this year’s champion, Bear 747.
The commercial leasing version of a tenant grabbing its own salmon for din-din from its landlord’s stream involves having proper procedures and remedies to ensure that the landlord meets its obligations to timely pay the lease’s tenant improvement allowance.
Some leases involve “turnkey” buildouts where the landlord performs the tenant’s initial alterations subject to a building or other negotiated standard.
But many tenants want to build out their own space to control the process, to save on costs or to create their own unique look (or any combination of the foregoing).
Leasing dollars are fungible, and the economic value of a given lease is based on the aggregate rent, “free rent” or abatement and/or other concessions such as an allowance from the landlord towards the tenant’s initial alterations.
These dollars may be structured differently to meet the parties’ various needs but all of these dollars belong to the tenant.
It is customary for the landlord to require that the tenant improvement allowance be used to improve the space and for payment to be made along with verification that the work is being properly performed in a lien free manner.
But since the tenant is paying a higher fixed rent because it agreed to receive some of these fungible dollars as a tenant improvement allowance, it is important that the tenant timely receive the funds.
Chow down on the following eight suggestions when protecting your tenant improvement allowance:
- Clearly state the amount. Perhaps obvious, but the exact amount of the full allowance should be set forth in your lease (and not that you are entitled to receive “up to” the designated amount).
- Provide notice/grace. While it is reasonable for your landlord to preclude payment if you are in default under your lease, this restriction should be limited to “monetary or material non-monetary” defaults and always after the expiration of notice and grace periods.
- Allow use for “soft costs.” Your landlord will want the allowance to be put into its building but you should be allowed to apply some portion (e.g., 10%, 15% or 20%) toward your permit and filing fees, designers’, architects’, engineers’ and other professional fees, project management, IT and telecommunication consultants and other so-called “soft costs” incurred in connection with the performance of the work.
- Quantify disbursement. Your lease should provide for regular monthly progress payments (not payment at the end) and specify the required submissions.
- Confirm these submission requirements with your construction advisors/architect to be sure they are feasible.
- Most disbursement requests include a certificate (often AIA G-702/703 forms) signed by either you or your architect (and not required for soft costs), itemized copies of invoices, and waivers of lien which (except for the first disbursement) are unconditional evidencing the payment for all work and materials for which you previously received payment and conditional for payment for work and materials in the latest disbursement request.
- In larger projects, you may be able to provide that if one or more lien waivers regarding work costing less than an agreed upon amount are not available, you may instead provide a certificate that the amount in question has been paid.
- Address holdback. Your landlord is likely to require that some portion of each disbursement be held back to ensure lien free completion of the work. This is true notwithstanding that you will no doubt already provide in your agreement with your contractor for retainage (most often of 10%) of each payment.
- Your landlord may want a similar retainage or may require that the allowance and any additional funds being provided by you to complete the project be paid together on a pro-rata basis based on the aggregate cost (or estimated cost) for the project.
- Full payback of the retainage is usually upon completion of the project but you should provide for a reduction of the amount withheld (e.g., to 5%, 2.5%) upon “substantial completion” (meaning completion of the work other than punch list items, i.e., minor details of construction).
- Final Payment. Your lease should clearly indicate when any retainage or other remaining payments are to be paid. Your landlord may require some additional items such as “as-built” drawings, an architect’s certificate that all of the work has been satisfactorily completed substantially in accordance with the approved plans and specs, final lien waivers, temporary certificates of occupancy and all required governmental sign-offs.
- Include remedies. If your landlord does not timely pay out all or any part of your allowance and does not cure such default after a reasonably short notice period you will require remedies.
- You should be entitled to offset the unpaid amount (with interest) against subsequent installments of rent. Your landlord will likely request that it have some period of time (e.g., 15, 20 days) to dispute and suspend such offset by notice (reasonably specifying the basis for such dispute). However, you must include a dispute resolution mechanism by an independent third-party such as pursuant to expedited arbitration (with the right to offset if your landlord fails to pay the disputed amount after determination in your favor).
- If an offset is insufficient since it requires that you finance the project or because you have concerns about your landlord, you may require if you have sufficient leverage that your landlord post security (e.g., a letter of credit) for some or all of the allowance with an independent third-party, again, with a dispute resolution mechanism.
- Remaining Balance. Since the allowance is all part of your fungible tenant economic package, any portion of the allowance not disbursed should be credited against the base rent (not waived). If your landlord insists upon a forfeit of the allowance if not disbursed within a specified period of time, then this period should be reasonable with a comfort factor and subject to landlord delay and force majeure.
We will not ask for before and after COVID pictures from anyone other than the bear-lebrities below, but if you were able to bear reading through this newsletter and follow the suggestions above, your lease will be the clear winner with one fine looking “phat” tenant improvement allowance provision.